Following a recent hearing, we were asked by a Member of Congress: “How would higher-than-expected interest rates affect federal budget deficits over the next decade? In particular, what would be the effects of these scenarios:
Interest rates rise to their average levels over the 1991-2000 period;
Interest rates rise to their average levels over the 1981-1990 period; and
Interest rates follow a path that is consistent with the average of the 10 highest projections shown in the October 2012 and February 2013 releases of Blue Chip Economic Indicators.”
CBO projected Scenario 1 would have interest rates of 4.9% and Scenario 2 rates of 8.8%, as compared to the current 4% projection in CBO’s baseline analysis, from 2018 to 2023. In other words, interest rates would be much, much higher. Treasury note rates would also be higher:
Similarly, rates on 10-year Treasury notes would average 6.7 percent between 2018 and 2023 under scenario 1 and 10.6 percent under scenario 2, compared with 5.2 percent in the baseline projections.
What were the results? Devastating:
In other words, if interest rates go up even a little, the entirety of sequestration will be wiped out. And while entitlement spending will be the largest driver of our debt in coming years, interest payments on the debt will be even larger. The Treasury Department projects that interest will be almost as much a burden on the budget as budget as Social Security, and by the time today’s newborns are in their mid-twenties, interest will be the biggest item in the federal budget.
The only real answer to this problem is cutting spending. CBO notes a number of caveats to its estimates, including the impacts of inflation, an improving economy, and interest rates on the cost of interest payments. But only cutting spending, and substantively so, will prevent rates and payments from becoming unsustainable.
One other thing: CBO only examines publicly held debt, which is less than three-quarters of the total debt of the United States. So their estimates above are very likely to underestimate the total burden of interest payments on the federal budget.
Speaker Boehner and President Obama say we don’t have a spending problem now. They also have a bridge in Brooklyn to sell us.